When used responsibly, credit cards are a great financial tool. They’re perfect for shopping online and allow for easy, contactless purchases when shopping in store. Credit cards are incredibly convenient when traveling internationally (something we’ll do again, someday!) and often offer great member rewards such as gift cards, merchandise or even credit towards your monthly bill.
If you have a number of different credit cards in your name, you might be worried about how these accounts could impact your credit score. It’s common thinking to believe that closing a credit card will improve your credit rating but in some cases, the opposite could be true. Here’s a closer look at why cancelling a credit card may actually hurt your credit score (and a few times it makes sense to close your account).
How do credit cards impact my credit score?
Having a credit card (or several) can impact your credit rating in several ways. If you use your credit card regularly and consistently pay off the full balance, it’s excellent for your credit score. If you use a credit card and pay off most of the balance each month (well above the minimum payment), it shouldn’t have a significant negative impact on your credit score. However, if you carry a balance - particularly a large one - this can have a very negative impact on your overall credit rating.
Another point to consider is the limit on your credit card in relation to the balance you owe. It reflects well on a cardholder to have plenty of credit available on their credit card (meaning the balance owed is well below the credit card’s limit). This is sometimes even more important than the actual amount owed, as it demonstrates restraint and shows that you aren’t in the habit of maxing out your credit card. For example, if you owe $4500.00 on a credit card with a $5000.00 limit, that typically looks worse to creditors than owing $4500.00 on a credit card with a $10,000.00 or $20,000.00 limit. While it’s the exact same amount of debt, it’s framed quite differently. If you were to apply for additional credit - for example, a personal loan or a mortgage - this ratio is something that lenders would look at and use in their decision-making process.
What happens to my credit score when I cancel a credit card?
Cancelling a credit card can have a temporary negative impact on your credit score, so it’s important to weigh the pros and cons of closing your account. Here’s a rundown of when it’s beneficial and when it should be avoided.
Good reasons to cancel a credit card
It makes sense to cancel a credit card if you find yourself going further into debt because having access to more credit encourages you to spend more. Simply put: if your credit cards are too tempting, get rid of all but one (and consider lowering the limit on the remaining card if overspending continues to be an issue). There’s no sense in keeping cards open to improve your credit score if in actual fact, having access to more credit causes you to incur more debt.
Another time it makes sense to cancel a credit card is if it has extremely high annual fees or interest rates. Department store credit cards are notorious for the latter, so be sure to look at the fine print! You may want to transfer your balance to a lower interest credit card or use a personal loan to pay off this debt and service it at a much lower interest rate.
If your credit card has been compromised, you may be better off cancelling the card— however, your credit card provider can advise whether or not this is necessary (sometimes, they’ll simply issue a new card while keeping the same account).
Finally, if you have a joint credit card with a partner you are separated from or divorcing, or a partner who is irresponsible with money, it makes sense to cancel the card and start fresh with a new account in your name only.
Bad reasons to cancel a credit card
Don’t cancel your credit card just because you aren’t using it. As we mentioned above, having unused credit can actually improve your credit score as it indicates financial responsibility and discipline. Just keep an eye on the account to ensure that no fraudulent activity is happening. As long as the credit card remains uncompromised, there’s no reason to close the account!
If you carry a balance on a credit card and are actively paying it down, keep the card open until the balance is completely paid off. When you close the account while still owing money on it, payments toward this debt won’t help your credit score. (Paying down debt helps your credit score, but not when an account has been closed.)
A common credit myth is that you should close down “extra” credit cards and personal loan accounts when shopping for a car, applying for a mortgage or trying to obtain a new loan. Unfortunately, this can actually have a negative impact on your credit card (sometimes temporarily). Instead, focus on paying down any existing balances as best you can before applying for new credit.
We can help
If you’re carrying credit card debt or have other financial challenges at this time, we are here to help. Please reach out to your local easyfinancial branch or easyhome store, or give us a call at 1-888-502-3279.